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Marcuard's Market update by GaveKal Dragonomics
With the votes counted and a new PM sworn in, it looks as if the euro system has helped give birth to the continent’s very own Hugo Chavez, with the third largest party in Greece’s parliament being neo-Nazis. Nice work!
With Spain going to the polls later this year and Italy never far from its next political imbroglio, Greece offers a glimpse of what Europe’s political future could look like. The question is whether the irresistible rise of Alexis Tsipras and his Syriza party points to a formal renunciation of North-imposed austerity that leads to a politically-driven eurozone break-up. The counter narrative being touted by realists is that Tsipras will quickly tack to the centre, arrange a palatable debt renegotiation and quietly drop the more wide-eyed promises made to Greek voters. Comparisons with Brazil’s Lula de Silva, and the fiery, but ultimately pragmatic government of Andreas Papandreou from 1981 are being heavily touted.
We have no particular insights into the Tsipras psyche, but see three basic scenarios that will have quite different investment implications and knock-on effects to the rest of the eurozone:
– Greece negotiates debt-forbearance and after threatening a default secures a new fiscal agreement and further fiscal transfers from Brussels that allows for public sector hiring, more generous pensions, etc…
– Maturities get stretched and Greece lowers its debt service share to well below 2% of GDP, but gets no new cash. Tsipras squeezes a few billion euros from redistributive taxes in an effort to make good on campaign pledges, but basically “does a Lula” by sticking with the fiscal plan.
– Blackmail efforts to secure fresh cash fail; Greece moves toward an official sector debt default and prepares for a post-eurozone future by launching a parallel drachma in order to pay for spending.
Renegotiating the debt should be the easy part in this looming game of chicken. Indeed, one of Syriza’s demands that actual interest payments fall to below 2% of GDP from 2.6% in 2015 looks do-able. More than three quarters of Greek government debt is held with the “official sector” through bilateral loans with EU states, and loans to the European Central Bank and International Monetary Fund. Greece pays a 50bp spread over 3-month Euribor on its bilateral loans and cutting this spread is unlikely to spark street protests in Dresden. Interest payments on loans made by the European Financial Stability Facility have already been deferred ten years and could be pushed out further.
The immediate issue is that the Greek treasury must redeem two bonds in June and August, with a sizeable chunk due to the ECB. The source of these funds is likely to be the European Stability Mechanism, the EFSF’s permanent successor. But to get such a disbursement Athens would need to be compliant with its structural adjustment programme. Similarly, Mario Draghi dangled a carrot last week saying the ECB could buy Greek debt once the bond redemptions were complete as at that point it would not be constrained by the maximum 33% debt holding rule of any member state.
Taking Syriza at its word, it does not want to leave the eurozone and 76% of the Greek population make the same claim. The question is what happens when the discussion in Brussels moves beyond debt restructuring to a fiscal renegotiation. One constructive argument that Tsipras can make is over Syriza plans to free up non-competitive sectors of the Greek economy and attack explicit rent-seeking activity in official procurement. Clipping the wings of tycoons and making them pay more tax within a framework of law will find few objections in Brussels. Whether that is enough to allow slippage on the key fiscal provisions under Greece’s bailout plan as agreed with the EU, IMF and ECB is another matter. The demonstration effect to the electorate in Spain, Portugal, Italy, et al, would clearly suggest that voting for anti-austerity populist parties delivers a painless increase in living standards.
Much depends on the personalities involved in this discussion. But there can be no doubt that the potential for a Greek default and eurozone exit has risen. As some often argue, countries default when most of their debt is held by foreigners and they run a fiscal surplus (soldiers, nurses and police still need to be paid the next day). Greece fulfils most of these conditions; last year it ran a surplus net of debt equal to about 2% of GDP, while outstanding Greek debt (excluding short term bills) in private hands is about EUR 37 bln, with about EUR 6 bln held by Greek banks. By contrast, total Greek debt to the official sector is about EUR 262 bln. On this basis, Athens would seem to have reached the threshold where it could in fact “do an Argentina” and consider an outright default.
On balance, Greece seems more likely to sustain a middle way that involves Tsipras moving to the centre and disappointing his more radical supporters. To be sure, any agreement leading up to the summer bond repayment deadline will be messy. But if compromise is reached, Greek bonds — although likely to be volatile in the coming months — should provide a strong opportunity for capital appreciation.
